Corporate Aviation Fleet Planning: Tax considerations for the next five years

Right now is the perfect time to dust off that fleet plan and review!

By?Ryan DeMoor?-?MySky?- Head of Aviation Tax - August 22, 2022

After the last few years of operating in a business environment dictated by the Covid-19 pandemic, the market for corporate jets has returned to a strong and healthy state of growth. The number of jobs and degree of economic benefit the production of business aircraft has produced is highly encouraging – aircraft orders have skyrocketed to the extent that the industry could be on the precipice of an overheated market.?

A few similarities can be drawn to the last uptick of this nature between 2006 and 2007. Aircraft manufacturers, tempted by a rising demand, overproduced, leaving the market vulnerable to a decade long depression following the economic crash of 2008. Now, in the face of a reinvigorated market and ramped up production, is there a looming detail in U.S. tax code that could impact aircraft owners?

Two tax law changes in the Tax Cut and Jobs Act (TCJA) of 2017 working in tandem should quietly motivate sharp buyers to accelerate their fleet replacement plans. To provide a better understanding of what the business aviation market for aircraft owners, charter operators and corporate flight departments may look like in the next five years, the following article examines two elements of U.S. tax code that may influence fleet decision making.

Bonus Depreciation

Since the early 2000s, Bonus Depreciation has been a valuable means of reducing the tax burden on organizations owning and operating business jets. Introduced following the events of 9/11 as a means of stimulating the economy into recovery, bonus depreciation is an acceleration of benefits that is made available to corporate entities in the form of a tax deduction. Usually, depending on the type and use of an aircraft, bonus depreciation falls into one of two asset classes and the tax benefit can be claimed between five to 12 years after purchase. Bonus or ‘accelerated’ depreciation allows a company to deduct additional amounts in depreciation earlier than the standard period.

Initially, the policy began with a 100% deduction allowed on new purchases, which meant that a company could take the entire deduction in the first year of use of the asset. In the case of a new aircraft initially valued at $50 million, this meant the entire amount could be used to offset income tax, thereby reducing a company’s overall tax bill.

The value of bonus depreciation has waxed and waned throughout the 21st century: in the early 2000s it was valued at 30%-50%, before being removed from policy. It was subsequently brought back into play at 50% after the financial crisis of 2008, grew to 100% thanks to the Tax Relief Act of 2010, and eventually returned to 50% in 2011. Bonus depreciation was on track to be removed completely by 2019, but in 2017, the TCJA was passed with two significant changes made to bonus depreciation. First, bonus depreciation could now be applied to Used aircraft purchases, and second, 100 % bonus depreciation was reinstated until 2022, with an intended ladder step down of 20% each year beginning in 2023 and ending completely in 2027.

The concept of bonus depreciation has become a highly politicized area of interest and is used on both sides of the aisle in federal budget negotiations. With an election year coming in 2024, the market must be prepared for the possibility of further changes to the tax code. There are no guarantees that bonus depreciation will be extended.

1031 like-kind exchange

Dating back to 1921, the concept and tax law of like-kind exchanges relates to the International Revenue Service (IRS) code section 1031 that was initially passed to address real estate and business assets.

A like-kind exchange meant that when an asset was sold, the gains made from the sale of the asset became taxable income for the company, unless those gains were then used to purchase a like-kind asset to replace the sold asset. If done correctly, the gain could be rolled into the tax depreciation of the purchase of the new asset, effectively deferring tax payment until the next sale. This rollover strategy could - in principle - continue ad infinitum, creating a situation in which no taxes would be due on an asset until an ultimate final sale.

Section 1031 was not widely used for aircraft until 2000 when the IRS introduced the concept of reverse exchange which allowed assets to be sold either before or up to 180 days after the purchase of the new asset. This 1031 structure lasted until 2017 when the TCJA was passed into law, repealing 1031 like-kind exchanges for all assets except real property. While this change in code cost companies the ability to move gains into a next purchase, any related inconvenience was largely mitigated by the tax benefits of 100% bonus depreciation.

The Combination

With these two elements of tax code combined, taxable gains on a sale, even on used aircraft, can be offset by bonus depreciation so long as the transactions occur within the same tax year. In this manner, companies can still optimize their tax deductions with little extra planning despite the loss of more liberal like-kind exchange policies.

However, the 20% ladder step down of bonus depreciation set forth for the next five years means the market faces a gradual loss of flexibility in determining tax deductions for aircraft purchases - with no recourse for rolling gains into future purchases. This lack of flexibility will inevitably cause some companies to have to pay a tax bill for the sale of an aircraft for the first time in a very long time. Some companies who have gone through 60 to 80 years of 1031 like-kind exchanges are now meeting a hard, cold end to their advantage.

With the ability to offset gone, there is an impending inflection point coming for the fiscally sharp buyer; this emerging reality should prompt wiser corporate aircraft owners to make thorough reviews of fleet planning with an end goal of replacing their aircraft sooner rather than later. With an election year coming in 2024, the market must be prepared for the possibility of new changes in tax code. There is no guarantee that 1031s will ever return for corporate aircraft, but by replacing one’s fleet prior to bonus depreciation disappearing, aircraft owners can buy time (approximately eight years, the average initial owned lifespan of a corporate aircraft) to see if the fiscal winds change to a more favorable direction – either by reinstituting bonus depreciation, or by the return of 1031s.

The tax implications of a fleet plan absolutely need to be taken into consideration when determining the pace of aircraft replacement. Being proactive with these kinds of purchase decisions buys the time to wait out either the return of 1031’s, or the next round of bonus depreciation. A little planning and coordination between financial and flight departments is probably the best way to prevent the tax man from showing up unannounced at your doorstep with a 60-year-old tax bill.